Swedish Utility Vattenfall Rating Lowered To 'BBB+' On Deteriorating Performance; Outlook Negative

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1 Research Update: Swedish Utility Vattenfall Rating Lowered To 'BBB+' On Deteriorating Performance; Outlook Primary Credit Analyst: Lovisa Forsloef, Stockholm (46) ; Secondary Contact: Alf Stenqvist, Stockholm (46) ; Table Of Contents Overview Rating Action Rationale Outlook Ratings Score Snapshot Related Criteria And Research Ratings List SEPTEMBER 28, Standard & Poor's. All rights reserved. No reprint or dissemination without Standard & Poor s permission. See Terms of Use/Disclaimer on the last page

2 Research Update: Swedish Utility Vattenfall Rating Lowered To 'BBB+' On Deteriorating Performance; Outlook Overview Vattenfall's business risk profile has weakened moderately due to deteriorating industry conditions, falling profitability, and pressure on cash flows. We believe these factors are also negatively affecting Vattenfall's financial risk profile, which we now view as "aggressive" as opposed to "significant" previously. We are lowering our long-term rating on Vattenfall to 'BBB+' from 'A-' and removing it from CreditWatch negative. The negative outlook indicates the possibility of a further downgrade if Vattenfall is unable to improve its financial risk profile and credit metrics to a level we view as commensurate with its 'bbb' stand-alone credit profile over the next months. Rating Action On Sept. 28, 2015, Standard & Poor's Ratings Services lowered its long-term corporate credit rating on Sweden-based utility Vattenfall AB to 'BBB+' from 'A-'. The outlook is negative. The 'A-2' short-term corporate credit rating and 'K-1' regional scale rating on Vattenfall were affirmed. At the same time, we lowered our issue rating on Vattenfall's senior unsecured debt to 'BBB+' from 'A-', the rating on the subordinated debt to 'BBB' from 'BBB+', and the rating on the junior subordinated debt to 'BB+' from 'BBB-'. We removed all the long-term ratings from CreditWatch, where they were placed with negative implications on July 24, Rationale The downgrade primarily reflects increasingly difficult industry conditions, resulting in falling profitability and pressure on Vattenfall's cash flows. We believe these factors have moderately weakened Vattenfall's business risk profile, and will also likely erode its credit metrics over the near term, with a negative effect on the financial risk profile. These factors have led us to revise our assessment of Vattenfall's stand-alone credit profile (SACP) SEPTEMBER 28,

3 downward to 'bbb' from 'bbb+'. Our long-term rating on Vattenfall is one notch higher than the SACP because we believe there is a "moderate" likelihood that the company would receive support from its 100% owner, the Swedish government, in a financial stress scenario. In our view, deteriorating market conditions and regulatory uncertainty have weakened Vattenfall's business risk profile moderately. Suppressed power prices, with no sign of near-term recovery, and sluggish demand will likely continue to constrain profitability and cash flows. However, we still view the business risk profile as "strong" because the company continues to benefit from a substantial share of stable cash flows from electricity distribution and district heating operations (about 30% of EBITDA in 2014), as well as from its low-cost Nordic hydro generation, which represented close to 20% of its total electricity production in In addition, Vattenfall is gradually increasing its wind-power generation, which benefits from subsidy schemes, and has initiated the sale of its German lignite operations. Although the outcome of an eventual sale is unknown, we consider that such a disposal would reduce the company's exposure to negative political interventions and significantly lower carbon emission costs, although decreasing fuel mix diversity. The difficult market conditions will likely also lead to weaker credit metrics for Vattenfall over the near term. We now believe that adjusted funds from operations (FFO) to debt in 2015 will be much lower than the 20.4% in 2014, and below our previous expectations. In addition, higher asset-retirement obligations, largely a result of the low-interest-rate environment and projected cost increases, have added to the company's adjusted debt over the past year. This is partly offset by reduced investments, asset disposals, and the owner's decision to not require dividends in 2014 and Based on these assumptions, our forecast credit metrics are more commensurate with an "aggressive" financial risk profile. However, we anticipate that Vattenfall's management will take measures that help improve its credit metrics, in line with its financial policy and a "significant" financial risk profile. These include continued reduction of investments, or the sale of the German lignite operations, if it materializes and has a positive financial impact. Consequently, we apply an upward adjustment of one notch to the 'bb+' anchor to reflect our view of the company's financial policy as positive. In addition, we apply another notch of upward adjustment, based on our positive view of Vattenfall under our comparable ratings analysis, owing primarily to Vattenfall's moderate share of stable regulated activities, which reduces cash flow volatility. Our view of a "moderate" likelihood of timely and sufficient government support for Vattenfall stems from our view of the company as a government-related entity (GRE). Under our methodology for rating GREs, this reflects our assessment of Vattenfall's: "Strong" link with the Swedish government, which owns 100% of Vattenfall through the Ministry of Enterprise and Innovation, and the government's influence on the group's high-level strategic decision-making; and "Limited" role for the state, given the group's strong, but not dominant, SEPTEMBER 28,

4 market position in Sweden, significant exposure to non-nordic markets, and its operations in a fully liberalized electricity market, which implies that it could conceivably be replaced by a private-sector entity or another GRE. In our base case for Vattenfall, we assume: Decreasing EBITDA in 2015 as a result of lower power prices, followed by a recovery in 2016, partly owing to higher volumes due to increased generation output at Nordic nuclear plants and new production assets coming on stream. Capital expenditure of about Swedish krona (SEK) 25 billion (about 2.5 billion) in 2015 and about SEK20 billion in No dividends in 2014 or Based on these assumptions, we arrive at the following credit metrics for 2015 and 2016: FFO to debt of about 16%-18% in 2015 and about 20% in Debt to EBITDA of about 4x in 2015 and slightly lower in Liquidity We assess Vattenfall's liquidity position as "strong" under our criteria, based on our expectation that the group will maintain liquidity sources that exceed liquidity uses by 1.5x over the near term. We also assume that liquidity sources will exceed uses even if EBITDA were to decrease by 30%. We further believe that Vattenfall has a solid relationship with its banks, a high standing in the credit markets, and prudent risk management. We also understand that Vattenfall's credit facilities are free from onerous financial covenants. According to our calculations, Vattenfall's liquidity sources comprise, as of June 30, 2015: Reported cash and cash equivalents of SEK48 billion. Access to committed credit lines of SEK18.5 billion. FFO that we forecast at slightly below SEK30 billion. Expected cash outflows as of June 30, 2015, include: Debt maturities of about SEK36 billion in the coming 12 months (including the outstanding balance of about SEK19 billion on the remaining 21% of shares in N.V. Nuon Energy, paid on July 1, 2015) and SEK1 billion in the subsequent 12 months. Capital expenditures of about SEK22 billion over the coming 12 months, which fall to about SEK20 billion in the subsequent 12 months. No expected dividends. Outlook The negative outlook reflects that we could lower the ratings further if Vattenfall is unable to maintain a financial risk profile and credit metrics commensurate with its 'bbb' stand-alone credit profile over the next months. We base our opinion on a number of factors, including the ongoing SEPTEMBER 28,

5 pressure on power prices affecting earnings and operating cash flows, potential poor returns on new investments, political and regulatory uncertainty in Germany, and risk from lack of progress in cost-cutting and efficiency measures. Nevertheless, we recognize that the company could take several measures to strengthen its financial risk profile. Downside scenario We could lower the ratings if we believed that Vattenfall's credit metrics were unlikely to improve to a level consistent with the SACP and ratings over the next months, for example if FFO to debt were sustainably below 20%. We could also lower the ratings if we see tangible signs of weakening government support, such as the privatization of a significant part of the government's shareholding in Vattenfall. However, we currently consider this to be unlikely over the near to medium term. Upside scenario We could revise the outlook to stable if Vattenfall's credit metrics improved and were sustainably in line with a "significant" financial risk profile, including FFO to debt of at least 20%. In our view, this could materialize if, for example, Vattenfall succeeds in reducing costs and improving efficiency and took measures that support cash flow generation and debt reduction. Ratings Score Snapshot Corporate Credit Rating: BBB+//A-2 Business risk: Strong Country risk: Very low Industry risk: Intermediate Competitive position: Strong Financial risk: Aggressive Cash flow/leverage: Aggressive Anchor: bb+ Modifiers Diversification/Portfolio effect: Neutral (no impact) Capital structure: Neutral (no impact) Liquidity: Strong (no impact) Financial policy: Positive (+1 notch) Management and governance: Satisfactory (no impact) Comparable rating analysis: Positive (+1 notch) SEPTEMBER 28,

6 Stand-alone credit profile: bbb Sovereign rating: AAA Likelihood of government support: Moderate (+1 notch from SACP) Related Criteria And Research Related criteria Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015 Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014 Standard & Poor s National And Regional Scale Mapping Tables, Sept. 30, 2014 National And Regional Scale Credit Ratings, Sept. 22, 2014 Key Credit Factors For The Unregulated Power And Gas Industry,March 28, 2014 Key Credit Factors For The Regulated Utilities Industry, Nov. 19, 2013 Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013 Corporate Methodology, Nov. 19, 2013 Corporate Methodology: Ratios and Adjustments, Nov. 19, 2013 Methodology: Industry Risk, Nov. 19, 2013 Group Rating Methodology, Nov. 19, 2013 Methodology For Linking Short-Term And Long-Term Ratings For Corporate, Insurance, And Sovereign Issuers, May 7, 2013 Methodology And Assumptions: Assigning Equity Content To Corporate Entity And North American Insurance Holding Company Hybrid Capital Instruments, April 1, 2013 Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012 Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010 Use Of CreditWatch And Outlooks, Sept. 14, 2009 Hybrid Capital Handbook: September 2008 Edition, Sept. 15, Corporate Criteria: Rating Each Issue, April 15, 2008 Related Research Country Risk Assessments Update: July 2015, July 8, 2015 Standard & Poor's Assigns Industry Risk Assessments To 38 Nonfinancial Corporate Industries, Nov. 20, 2013 Ratings List Downgraded; Outlook Action To From Vattenfall AB Corporate Credit Rating BBB+//A-2 A-/Watch Neg/A-2 Nordic Regional Scale --/--/K-1 --/--/K-1 Senior Unsecured BBB+ A-/Watch Neg Junior Subordinated BB+ BBB-/Watch Neg SEPTEMBER 28,

7 Subordinated BBB BBB+/Watch Neg Commercial Paper A-2 A-2 Commercial Paper K-1 K-1 Additional Contact: Industrial Ratings Europe; Complete ratings information is available to subscribers of RatingsDirect at and at spcapitaliq.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at Use the Ratings search box located in the left column. Alternatively, call one of the following Standard & Poor's numbers: Client Support Europe (44) ; London Press Office (44) ; Paris (33) ; Frankfurt (49) ; Stockholm (46) ; or Moscow 7 (495) SEPTEMBER 28,

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